Cashflow vs. Profitability

Introduction

The first step toward an improved business environment is stepping out of denial with a deep sigh of relief as you begin to use new found energy to fix the problems instead of mask them. We all have ways of talking about specific situations that make them a bit more palatable.

Distinguishing Between Cash and Profit

One example we see frequently goes like this: “We been having some cashflow difficulty.” By definition, cashflow difficulties are rare. If your cashflow difficulties are recurring, what you really are struggling with is profitability, not cashflow. That’s a very important distinction.

Very profitable firms can have an occasional bout with cashflow disease. For instance, a client might withhold payment on a large bill; a major project might have to be scrapped; or a key person might leave the firm.

On the other hand, firms that consistently struggle with cashflow cannot, by definition, be profitable in any real sense. But we talk about “cashflow difficulties” because that phrasing makes it seem like we are being tossed by the vagaries of the marketplace, as if somehow this is a problem that is out of our control.

And there seems to be little connection between volume of work and cashflow struggles. Some of the clients we help are terribly busy but still not profitable. Those are often the firms that have misunderstood marketing (marketing is about control, not growth).

Starting With Candor

Why is this important? Back to the original point. Unless you admit that the core problem is profitability, you’ll make unwise decisions about cashflow. That might mean incurring fixed obligations when you can’t afford them just to get out of the immediate crunch (credit line abuse, leases for depreciating assets, etc.).

Here’s a suggestion. Don’t manage your business based on cash in the bank. It’s important to have it (at least two month’s worth of overhead), but it’s an indicator far too close to the events at hand to provide any meaningful information on the health of your business. Think of measuring cash as measuring how hungry you are at any given moment. One cheeseburger will fix it, at least temporarily.

And don’t even pay too much attention to your income statement, either. It’s a much better indicator of your health (if it’s on an accrual basis), but it still gives you information about recent, short periods of data. And it doesn’t fully account for what you do with the money once you get it. Think of measuring profitability as getting on the scale to check your weight. If you had a supersized drink with that cheeseburger, you are going to weigh two pounds extra, whether it was water or 250 calories of drippy sweet cola.

The slowest moving...and most accurate...method of measuring your health is to look at your balance sheet. Like nothing else, this accounts for nearly all of the decisions you’ve made. More specifically, compare your equity (assets minus liabilities) every quarter and chart it for comparison purposes. Look at the direction of movement, not the speed of movement. Think of this as measuring your body fat or taking a treadmill test. One cheeseburger won’t affect it, but a bunch of them will.

Taking the Next Step

So you’ve read this far and buy the argument. You are busy, your clients love what you do for them, but you’re ready to join Cashflowers Anonymous and admit that the problem is deeper. Don’t you dare reach for that “raise our hourly rate” button! If you want to position yourself higher in the marketplace, raise your rates. But that’s another subject.

If you want to make more money, though, quit subsidizing clients and start charging what it really takes to get the job done. Until you fix that, you’ll be forever plagued with a problem that should be rare.

And start by admitting that you have a significant profitability issue.

Download Full Article (170 KB pdf file)